By Gillian Tett (Little, Brown £18.99)
The Storm
By Vince Cable (Atlantic Books £14.99)
As the western world limps towards the end of the new century's first decade, it's worth pausing to consider three successive, self-inflicted blunders the last ten years have seen. The first was the dotcom crash of 2000-02. The second was the debacle of Iraq which—at enormous cost in lives, morals and money—bluntly proscribed the limits (and utility) of western military power. The third is the credit crunch of 2007-09, still unfolding before our eyes.
These two books cover the latter ground in complementary styles. Gillian Tett of the Financial Times combines her experience in reporting on the credit markets with her academic career in social anthropology to produce a story that has an almost mythic quality: that of the credit derivatives team at the blue chip US bank JP Morgan.
The team Tett focuses on was among the first to originate the credit device known as a Bistro (an acronym for Broad Index Synthetic Trust Offering). Created specifically for corporate loans, Bistros were also created specifically to circumvent the limits of the first Basel accord, an agreement which regulated the adequacy of a bank's capital. Bistros were the source of the first chill in credit markets.
The second chill came when the JP Morgan team's bright idea was adopted by others and applied to the repackaging of US mortgage loans—and in particular to the sub-prime sector, which offered mortgages to households with dubious credit ratings. Bistros had by now been replaced by Collateralised Debt Obligations, or CDOs—financial instruments whose worth was insured by their equally dubious cousins, Credit Default Swaps (or CDSs). And the markets in each of these duly grew into the hundreds of billions.
To JP Morgan's great credit, as told by Tett, it stayed largely absent from the mortgage business, despite several internal attempts to join in. The sums just could not be made to work under the bank's own risk/return models. Elsewhere, however, others were swept along by the frenzied growth of the business. Credit-less American citizens were tempted with debt beyond their means, banks paid scant regard to the quality of their products, investors piled into seemingly risk-free, high-yielding investments—and the debt rating agencies were, laughably, paid by the very banks whose products they were rating.
The party came to an end in early 2007, when a growing level of defaults in subprime mortgages caused the collapse of investor confidence. As Vince Cable is quick to point out in his book, however, the actual losses in the sub-prime mortgage market were no greater than the losses sustained during the US Savings & Loans bust of the early 1980s. It was the amplification of these losses by the speculative growth of CDOs and CDSs that produced such a catastrophic collapse among the major US financial institutions.
Tett goes on to chart the response of the authorities in Britain and America to the crisis—which involved cajoling fitter financial players to acquire their weaker brethren as well as the injection of massive amounts of liquidity into the banking system. It's a tale she tells engagingly, but she offers few prescriptions on what happens next beyond calling for a more holistic approach to the financial system.
By contrast, Vince Cable—a Liberal Democrat parliamentarian and former economist—offers a wide-ranging and populist account, taking us from the South Sea bubble of 1720 via a tour of the oil and commodity markets to the current disasters in both the City and Westminster. As befits an MP, he begins with the crash and eventual rescue of Northern Rock—and derides new Labour's deference to the City, which he rather snobbishly characterises as populated by proles who speak estuary English and blow their bonuses on champagne and cocaine.
Luckily, however, there are few such outbursts. Cable offers a good explanation of the effects of credit derivatives, and follows this with an overview of how the oil spike to $140 in mid-2008 combined with the worsening financial climate to produce the perfect storm of the title. He then broadens the canvas, discussing the economic growth of the coming superpowers—China and India—and the global system of financing. Before the crunch, China in particular had been financing the American deficit by purchasing US treasury bonds in vast quantities. Ironically, China is now such a large investor in America that it will be the Chinese who lie awake at night worrying about the state of the American economy.
Both books do exhibit some glaring lacunae, however. First, neither describes the role of the Clinton administration in encouraging the growth of the sub-prime mortgage business—or its repeal in 1999 of the Glass-Steagall Act, which had kept commercial and investment banking separate since 1933. Second, neither book takes a long critical look at either the British, American or international regulators, who could fairly be accused of having been asleep at the wheel. It's not that the regulation wasn't there. It simply wasn't used. As we now know, the Bank of England and FSA modelled a scenario similar to the Northern Rock crisis as early as 2004.
It's also misleading to tell the story of the last decade—as Cable does—with no mention whatsoever of Tony Blair, or of the Iraq war and the effect it may have had both on oil prices and American public finance. George W Bush gets a tick for recognising the importance of China, but no crosses for either Iraq or the financial crisis. Talk about asymmetric rewards. For the sake of the second decade of the century, let's hope we can learn the lessons of the first.
